Financing is impossible, deals are falling apart, lawsuits are coming -- real estate lawyers are the frontline workers of a sharp market drop.
We checked in with two legal experts about the market whiplash and the top three issues they're seeing right now.
John Zinati, Partner, Zinati Kay Barristers & Solicitors
John Zinati, Partner at Zinati Kay Barristers & Solicitors, has closed more than 25,000 real estate transactions and provides industry expertise for media outlets. He regularly publishes an educational newsletter and speaks at real estate offices and conferences.
Bhupinder Lamba, Founding Partner, GLG LLP
Bhupinder Lamba, Founding Partner at GLG LLP, leads the real estate practice group for the full-service firm. His clients include institutional and private lenders, purchasers, vendors, construction companies and real estate investment corporations, among others.
ZINATI: Financing falls through, buyers can’t close
Earlier this year, around spring, Zinati says buyers were caught between two very different market realities -- they were still bidding high in a hot market, but they had to close in a cool one.
"So the number one issue is buyers having trouble getting financing -- and the fallout.
One reason might be that they can’t qualify at the new rates. Or they bought a house thinking it had this value, and then the bank does the appraisal and the house comes in at a lower value. So now that buyer, although they signed a firm deal, finds out that they can’t get a mortgage because … from the bank’s perspective, the house is not worth what the buyer paid for it. So now we have a buyer who’s scrambling to close a deal. That’s the number one problem by far, across the board.
What they will do is ask the seller to discount the price. The seller has no legal obligation to do so -- we’ve actually had our sellers take a haircut, $100,000 less on a property, rather than lose the deal. Legally, they don’t have to… but their position was, 'John, I’d rather not have to go to court and fight over this and resell it. Let’s just take the money off the price. And let’s close the deal.'
Or they will ask the seller to take back a mortgage. Let’s say I’m buying your house and I paid $1,000,000. And because of the value of the appraisal, I’m only going to get $850,000 from the bank now. You can lend me that $150,000 -- it’s called the vendor take-back mortgage. So the seller basically is asked to lend the buyer the shortfall.
Now we have other kinds of problems with buyers getting financing. Let’s say you bought a condo four or five years ago, and now it's ready to be built. You qualified for the mortgage four or five years ago, when the interest rate was 1, or 2, or 3%. But now you’re borrowing, or trying to qualify, at a much higher rate. And most of those pre-approvals that you get when you walk into sales office, they expire after three years -- they rarely last right up until closing.
So we’ve had clients who’ve had to request extensions from builders. I had a guy who was trying to close his condo, he couldn’t qualify for his mortgage -- we asked the builder for a three-week extension. In the past, that might have resulted in some reasonable request for compensation -- $1,000 or $2,000, something like that. This builder actually said, 'Your deal is done. We’re going to terminate. Because in the last five years or so, that property has gone up by $200,000. And we’d be happy to take the property back and keep the deposits.' So we told our client, 'You have to go to a litigation lawyer.' There’s some duty in Common Law to be reasonable. And a litigator will basically tell the builder, 'Look, you want to show up before a judge and tell them that you want to kick this guy and his three kids out of the property? And wouldn’t give him three weeks time, after you extended it for all these years, and keep his deposit?' And [the builder] did give the guy an extension, but it cost him $18,000. For three weeks. And our client had to pay $3,000 to a litigation lawyer. And our client ended up paying almost 9% on his mortgage.
If you’re a buyer and you can’t close, you will lose your deposit. For sure. But the seller can come back and sue you. If I sold you my house for $1,000,000, and you gave me a $100,000 deposit, and you don’t close -- now I have to put it back on the market, and I get 800,000 instead of $1,000,000. The deposit is released to me, plus another $100,000 [can be pursued in a lawsuit]. You have to make me whole, back to $1,000,000. That’s what the law says."
LAMBA: Financing fallout
Lamba agrees -- financing has collapsed, buyers can’t close, deposits can be forfeit and purchasers can be sued. At the height of the market frenzy, buyers were bidding high with no conditions. Once the ink dried, rate hikes suddenly yanked financing out of reach -- and the no-conditions contract left no wiggle room.
"We’re seeing a lot of buyers coming to us, saying there’s a [financing] gap of $200,000 to $500,000 -- the highest I saw was $480,000.
I’m seeing multiple files every month going sideways. And in some cases, you’re able to negotiate -- [maybe] the gap is not too large. You know, maybe the seller says, 'Okay, I’ll meet you in the middle.'
As an aside, people don’t seem to understand that an Agreement of Purchase and Sale is a contract. I have so many calls with [buyers] and they’ll say, 'So I entered into an Agreement of Purchase and Sale.' And I’ll say, 'Is it firm?' And they’ll say yes. And I’ll say, 'So you have a binding contract.' And they’ll say, 'No, I didn’t sign a contract. I signed an Agreement of Purchase and Sale.' Just because you call it a different term doesn’t mean it isn’t a contract. There’s obviously a gap in terms of the public’s understanding and the significance of the act of signing and Agreement of Purchase and Sale.
What is happening is unnerving. And in a lot of cases, the purchasers, you feel bad for them, because they were just trying to do what they needed to do at the time when the market was hot. And then these hikes just flipped everything upside down. And it’s not necessarily the purchaser’s fault. [The market] has been growing at rates that are unsustainable and they did nothing about it. And then one day, they woke up and they said, 'Let’s slam the brakes.' And it’s sad, because for a lot of these people, it’s their life savings.
It’s a unique period in real estate. Often when you get into a contract dispute with somebody, there is a bad actor or somebody that is clearly at fault. In many of the cases at hand, they’re often just victims of this situation that’s been created."
ZINATI: Flipping condo contracts before they’re built
Condo assignments are another sore spot, Zinati says. Buyers would snap up a pre-construction condo contract -- or several of them -- with no intention to even close on the property, only to later assign it to someone else. They intended to sell the contract in a couple years with the assumption the market was only going up.
"Now a lot of things have happened with [assignments]. One is that it’s gotten tougher to assign, primarily because the value is not there anymore. Some people bought two or three, thinking that they can just flip it without even closing. Well, if the property hasn’t appreciated that much because the market is softened, you can’t necessarily flip it, you can’t necessarily get out of the deal. And you’re on the hook to close with the builder eventually.
It used to be that whether or not you had to pay HST on these assignment transactions depended on your original intention. So if your intention was to live in the property yourself, which everybody would say it was their intention, there wouldn’t be HST of 13% on the profit that you made. But the government basically knew that this was happening. And they made, at the beginning of this year, every assignment transaction, regardless of whether you intended to buy the property for yourself or not, is now subject to HST. So what you have now are people who are willing to assign out their contracts, just to break even, or just to get their deposits back.
They’re stuck. Even if they sold the contract, they’re still legally on the hook [if the second buyer also struggles to close.] They’re on the hook still to that builder -- just as much as the new buyer was -- and the builder can sue both of them to get his money."
LAMBA: Mortgage fraud
When buyers have a financing gap, they assume they can go to another lender for the difference. In many cases, this is not possible -- in fact, Lamba says, depending on the terms of your first mortgage, secretly securing a second mortgage can constitute mortgage fraud.
"There’s a lack of education -- buyers, and people engaging in the real estate market, don’t actually understand the different moving parts. I’ll have people come to me [with a financing gap] but their mortgage broker says, 'It’s okay, we’ll just get secondary financing.' So [the buyer will] get two mortgages -- one mortgage with, say, with one of the major Canadian banks, and then a second, which is a private mortgage, to come up with the difference. And they think this is a solution.
With secondary financing, there are some situations where they’ll allow it, but typically they do not. So [buyers] come to me and they say, 'Okay, I’m in trouble. The bank says I can’t have a second mortgage.' Well, this solution should have never been proposed in the first place. The broker who is selling you this product should have known that. And either they knew it and they wanted you to look the other way, or they didn’t understand the product they’re selling you.
It's mortgage fraud. Entering into an agreement, signing paperwork with the bank saying, 'These are the conditions I agree to follow to obtain a mortgage' -- and then doing the opposite, is fraud.
Deceiving a lender is not an option. [Buyers will] come back to me and they’ll say, 'Okay, well, I need help getting out of this deal.' Okay, so now we’re talking about something different -- we’re talking about damage control and seeing if we can maybe negotiate the price down, or if we can negotiate a walk-away where you pay the seller a certain amount, they let you out of the deal. So we’re seeing a lot of that as well."
ZINATI: Lawsuits are coming
Zinati predicts litigation is going to increase as losses pile up, and people need someone to blame.
"People are having to understand what happens when deals fall apart. When the market is declining, there are actual losses. And when people start losing, they start suing.
So let’s say you couldn’t close on my house. And now I’m suing you for $200,000 [because the price has dropped in the market]. You might say, 'Okay, I'm gonna go sue my realtor. Why did he let me buy this property firm?'
Litigators will be looking for people who they can hold responsible for the losses. Back in the early 90s, during the last crash, a lot of lawyers got sued. Because people look for who to sue for their losses. Lawyers, mortgage brokers, real estate agents.
I’ve actually had three litigators calling me saying, 'Look, if you have real-estate-related litigation, let me know.' Because they know that this is probably coming.
It’s a very tough thing for people to face litigation. It’s not for ordinary people. Litigation is expensive, messy, nasty. Most of my clients would avoid it as much as possible, but sometimes you can’t."
LAMBA: Renters won't leave
A stifling rental market means some renters are refusing to leave when their landlord sells, starting a roughly six-month process, which can bring deals to collapse. The seller, both hands tied, is on the hook for breach of contract.
"I'm getting a lot of calls about this recently. [A seller] served their tenant with paperwork, saying they need to vacate the property. The tenant looks around and says, 'My rent is going to go up $800, $900 a month -- I’m not leaving.' So now it’s the process to get them out. And if you properly serve them, then we have grounds to have them vacate. If the tenant does not agree to leave then you need to go to the Landlord and Tenant Board. Most closings are a month to two months. The Landlord and Tenant Board, you're probably looking at six months. So how are you going to close on time?
The Residential Tenancies Act is, I think, pretty tenant-friendly. And I think the concept behind it is, you know, there’s a power imbalance in law. These landlords are powerful and have means and tenants don’t -- that’s not always the case. Especially downtown Toronto. A lot of landlords that are calling me right now are people that save their whole lives to get an investment property to have an asset for them to pass on to their children, hopefully one day. And their tenants aren't unsophisticated -- they’re young professionals that are educated and make a good amount of money, understand the leverage that they have due to the Act, and are not leaving. In some cases, these landlords are hemorrhaging money and they’re forced to sell … And now, in two months, [the landlord says,] 'I have a closing date that I’m not going to be able to meet -- I’m going to be in breach.'
You could argue [the renter is] a bad actor, but you know, when the market has changed so quickly, it might be out of necessity that they’re doing this -- they can no longer afford to live in Toronto and be close to the job."